Reflect for a moment on the history we are witnessing. Congress is going to pass a $700,000,000,000 bailout of the banking industry.
In presidential election years, legislation rarely gets through Congress. Everyone is too busy playing partisan politics and posturing for the election to pass laws. Late in the election cycle, Congress goes home to campaign, and nothing gets done. We are at that moment, and yet, despite 90% or more of the electorate being against the bailout, Congress is going to pass it, and President Bush is going to sign it into law. The bill is going to pass with bi-partisan support. This is no small spending bill. We are talking about $700,000,000,000! And we are spending this money when the government is already running huge budget deficits. Amazing!
That kind of bi-partisan support, in the face of overwhelming public opposition, on a bill that large is unprecedented. We really do live in interesting times.
The reason for needing this bill is actually quite simple: our entire banking system is insolvent. The losses hidden in off-balance-sheet investments exceeds the total capitalization of our banking system. If banks were to take write downs of these securities to their true market value (essentially zero,) we would not have a functioning banking system. It is bankrupt.
Imagine a life without banking: no loans, no credit, no commerce, no economic activity other than all-cash transactions. This would not put us into the Great Depression; it would put us into the Middle Ages. This is what Bernanke and Paulson told Congress behind closed doors, and the ramifications of this reality scared them $hitless. As it should. Congress had to act. It ticks me off, just like it does everyone else, but they had to act.
Now, we the taxpayers of the United States of America are going to have to pay for the reckless irresponsibility of those greedy and sometimes clueless individuals who were in charge of our financial system. This is the end game all of us writing about the housing bubble feared most. The responsible are going to pay for the irresponsible. Actually, it is worse than that -- the responsible and the children and grandchildren of the responsible are going to be paying for the Great Housing Bubble. It is a reality we are going to have to accept. What is done is done.
Unfortunately, this will probably not be the end of the bailouts. Today, WAMU is being taken over by the JP Morgan. If the deal had not been reached, it would have been the biggest banking failure in history. It would have bankrupted the FDIC which would also have been looking for a federal bailout. Perhaps this bill will prevent other bank failures, or perhaps not. We dodged the WAMU bullet, but I wonder what back-door bailout prompted JP Morgan to buy an insolvent bank? The US auto industry will probably also get a bailout.
I want my bailout too. I wonder when they will be sending out the next round of stimulus checks...
For today's featured property, we are going to look at another Turtle Ridge Dreamer. With all the discussion about a housing bubble, a massive government bailout, a severe recession and the utter collapse of our banking industry, it sure seems like a good time to sell a house. And although this house was purchased in 2004, it surely must have appreciated 60% since then. WTF!
Generation Y began buying starter homes in earnest during the Great Housing Bubble. Generation X is just now coming into their prime earning years, and many of them bought move-up homes at inflated bubble prices. The Baby Boomers took their equity and bought multiple properties during the bubble. They all have one thing in common: they are all part of Generation Pwned. Pwned has many definitions, but it generally refers to a state of being defeated and helpless. People who paid bubble prices or HELOCed themselves into a massive debt are pwned by their houses and the housing market. I first wrote about this in America’s Debtor Prisons. Unfortunately, I know several families who this describes. All are overburdened with debt, and they were counting on increasing income and increasing home prices to finance their lifestyles and their family's future. It isn't going to turn out well for them.
Even if these people get a workout that allows them to stay in their homes, the terms of the workout are not going to leave them much to live on. Any workouts are going to have the highest possible DTI the government thinks you can handle (currently 38%,) and to qualify for the workout, the homeowner must give up half their future appreciation -- if there is any. Most would be better off walking away. Anyone paying 38% of their gross income (that is gross not net) to their housing costs, plus trying to finance car payments and credit card debt is going to find it very difficult. This is not going to be a short-term condition. Rapid house price appreciation leading to a HELOC dependant lifestyle is not going to happen any time soon -- if ever. Many of us have had to tighten our belts during the recession, but these people will not see any improvement in their finances when conditions improve. They are truly pwned.
Those that participated in the housing bubble (bought late or borrowed much) will end up breaking down into two groups: those that are pwned, and those that lost their houses. The pwned group is facing a life of indentured servitude to massive debt obligations and little or no hope of financial recovery. Those that lost their houses will have to deal with bad credit and feelings of failure. I can't decide which group I would rather be in. Neither alternative is very enticing. I am very thankful I was one who did not participate.
Today's featured property is in the "borrowed much" category of housing bubble participants. These people did not make the mistake of buying at peak prices. In fact, they bought at the bottom of the last cycle. However, they too drank the kool aid, and now they have lost their home and their wealth. Another casualty of the Great Housing Bubble.
In the next week or two, Hank Paulson is going shopping with a $700,000,000,000 credit card courtesy of Congress and the Federal Reserve. What is he going to do with that money? How wisely will he spend it? He faces a dilemma that has no resolution. If he pays fair market value for the securities he buys, he will fail to recapitalize the banks, and the economy will continue its downward spiral into the crapper. If he overpays for the securities to recapitalize the banks, the taxpayers will lose a great deal of money, and he will be accused of favoritism by just about everyone. So what should he do? Look out for the taxpayers, flush the economy and plunge us into a depression? Or does he screw the taxpayers and enrich his buddies and save the economy? Is this a false dichotomy? I don't think so. I am glad I am not the one making these decisions. In the end, all of his actions will be justified as "necessary" to save the economy, and the justifications may accurately characterize the situation. There will be no way to know. The severity of a problem you avoid is always an unknown open to speculation.
In yesterday's post, I reminded everyone of the reasons we are in this mess in the first place. When you strip away all the complexities and look to the root of the problem, you find individual borrowers like today's that took on more debt than they can handle. If this had not occurred, if people had not overpaid, HELOCed and generally over borrowed, prices would not have bubbled. Everyone would be making their house payments, and none of this would have happened.
Realtors are infamous for peddling the fallacies of housing leading to a housing bubble (The deception with tact). Of course, buyers want to believe in the fantasy of perpetual appreciation (If this is up, then I'm up). And few owners want to take responsibility for their decisions when their plans go astray (You run for cover and there's heat). But they are not alone. The lenders do not want to take responsibility either, and we will end up paying for it (I've got to say enough's enough, Bigger the harder he falls). Does anyone think the proposed bailout that is likely to be passed will solve all our problems? (But when the wrong antidote, Is like a bulge on the throat) It won't save housing prices, and one can only speculate on whether or not it saves us from financial Armageddon.
So where does this all end? When do the bailouts stop? Each one of these bailouts has been sold to us based on the belief that the alternative was too dire to contemplate. One thing leads to another.
Let's review the chain of cause and effect lest any of our politicians forget why these massive bailouts are necessary. Realtors peddle fantasies of unlimited wealth that leads to people wanting to overpay for houses. The desire for real estate at any cost provides an opportunity for lenders and mortgage brokers to make huge origination fees if they can lower standards and qualify more people. Appraisers use the comparative-sales approach which justifies current pricing based on the irrational behavior of buyers. Investors in mortgage backed securities enable the originations by purchasing any loan they can get. Default insurance companies like Freddie Mac, Fannie Mae and AIG provide false assurances to investors that they can insure their losses. Ratings companies provide dubious ratings that puts even more confidence into investor's decisions. All of this together leads to a massive inflation of house prices. One thing leads to another.
Now, back to our buyers. People who overextended and overpaid for real estate cannot afford their payments. They are insolvent. This leads to defaults which leads to forced sales which leads to lower prices. The lower prices distresses more homeowners leading to even more forced sales and even lower prices. The defaults and resulting losses cause lenders to become cautious and tighten lending standards. This leads to fewer qualified buyers and a reduction in demand leading to even more price drops. The losses by lenders causes default insurance providers to pay claims. They have written more policies than they can cover, so they go bankrupt. The losses by lenders also lead to a depletion of their capital reserves which leaves them less money to lend. This leads to a massive credit crunch and widespread monetary deflation as the money created by lenders when they originated the loans disappears into the ethers. It also leads to a dramatic slowdown in our economy as the circulation of money slows and commerce dries up. All of this leads us to today where we are being forced to engineer massive bailouts of anyone who provided or insured loans. One thing leads to another.
So what comes next? A severe economic recession, more layoffs, less income, massive government debt, and lower house prices. Followed by increased personal savings, economic recovery and renewed (albeit tepid) house price appreciation. One thing leads to another.
Today's featured property is another example of house speculation gone awry. We have a lot of foreclosing to do before the system is truly purged of these exotic loans and overextended owners.
This financial crisis is stressful. It makes me long for a quiet home on the plains of Wyoming. Of course, I would have to finance that house so the financial crisis I am seeking to leave behind would follow me wherever I go. There really is no escaping this problem. My industry has already been decimated by the fallout of the Great Housing Bubble, and now the seizure of the credit markets brought about by the excesses of the bubble is causing problems in every industry.
When lenders lose faith in the ability of borrowers to repay them, they stop loaning money. Right now, lenders are not sure if anybody can pay them back because nobody knows where all the toxic waste is hidden. Until these valueless securities are brought into the light out of the darkness of off-balance sheet special investment vehicles, lenders will not know who is solvent, and who is not. Under those circumstances, it is prudent not to lend. As long as that situation exists, the credit markets will remain seized up, and our entire economy will spiral into the abyss.
I have believed we were in for a very severe recession caused by a
credit crunch for some time. There have been several others who foresaw
the chronic problems caused by widespread borrower insolvency, but few
foresaw how acute the problems became recently. For the last few years, I have felt a bit like the character Sarah Connor from the Terminator series. She knew the Armageddon of the future and had to live with that knowledge for years while everyone else got to exist in blissful ignorance. The blissful ignorance of our nation's insolvency problem is gone. We have eaten the Forbidden Fruit of the knowledge of evil in our financial system. Our national stress level will rise noticeably as a result.
Americans are resilient. The prognostications of our status as a third-world country are greatly exaggerated. We will get through this financial winter, and when we do what will emerge in the spring will be a stronger America. (Anyone else remember the recession of the early 80s?) This is not a trite recitation of bullish nonsense, but an observation of past history and a belief in the collective intention of all Americans to excel and be our best. We will never become a third-world country unless we give up and allow it to happen. That isn't the behavior of Americans I know.
There has been much discussion on what it will take to get us out of this mess. Some point to stabilization of house prices, some point to purging the system of toxic loans, and some point to restoring confidence in our financial markets. It will require all three. Realistically, the first will not happen until prices drop to where people can afford a home and be financially solvent, the second is going to require the passage of time and/or a massive government intervention like the one being proposed, and the third will be the passive result of the first two. None of this will happen quickly.
House prices simply cannot be supported at current levels. The only way they got here was through the use of unstable exotic loan programs. The amount of debt supportable by people's real incomes on a sustainable, solvent basis is too small to support today's prices. Prices will fall to supportable income levels because they must. People will not be given the ability to bid prices any higher by lenders and investors. Without the big loans, we can't have big prices. If anyone is bullish on house prices in these circumstances, please let me have some of what you are smokin'.
Today's featured property was owned by an insolvent borrower. There was no way he could afford the debt he had accumulated on the house, and the market has purged itself of this problem with another foreclosure. Absent a massive government intervention (and perhaps even with one,) this is how the market will deal with the problem.
"[A]s the Fed chairman, Ben S. Bernanke, laid out the potentially
devastating ramifications of the financial crisis before congressional
leaders on Thursday night, there was a stunned silence at first.... Senator Christopher J. Dodd [said] the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”"
The IHB Forums are a great resource and there are many solid contributions being made there every day. Some of you have been hanging out there for well over a year and a half. If you haven't stopped by, check it out. Recently, we had a new member, Cuatro, join the forums. He created a topic on Tips for leasing an IAC apartment. There is some great advice there so I thought I'd put it up on the blog for the weekend post:
Tips for leasing an IAC apartment:
Leasing Consultants (LCs) are NOT the enemy. Rather than viewing them
like other sales people, consider the following. The typical IAC
Leasing Consultant has zero interest in the amount of rent you pay for
your apartment. They are paid on a tier system that rewards the number
of leases they get signed per month...period. They will usually do
anything in their power to get you the best deal, because at the end of
the day, your signature on a $1200 studio pays the same as your
signature on a $3000 3x2. Their first and foremost priority is to fill
their property. (As an interesting aside, IAC LCs make between $32k
and roughly $85k per year...the primary difference is volume).
Visit the property when you are ready to make your decision. Never
give the impression that you won’t reserve an apartment on that first
visit. The sooner you tell them you are ready to move, the more likely
you are to get the best deal. NEVER say you are looking to move 45+
days from now. As a general rule, the best deals are on vacant
apartments. Vacant apartments must be moved into within 2 weeks. If
you are looking to move more than 2 weeks out, you are automatically
going to be offered apartments that are “on notice” with other
residents currently living in them. Discounts on these apartments are
rare and always significantly worse than vacant apartment specials.
If I were the king of the world; Tell you what I'd do... I'd throw away the loans and the moans and the unknowns; Make home sweet home for you...
When I started writing for this blog, part of my drive was emptying my Reservoir of Schadenfruede. It has grown beyond that, and I appreciate all the people who thank me for convincing them to wait and saving them a great deal of money. I am not a pessimistic or bearish person by nature, and I would rather everyone experience the joy of living rather than the pain and stress of the collapse of an epic financial bubble. However, I am a realist who is willing to face the truth come what may. The truth is prices have fallen, and they will continue to do so. The government may be able to ease the transition to lower prices and borrower solvency by keeping interest rates low for a time. However, sub-6% mortgage interest rates will not be available forever, and after a big push to restructure and refinance existing borrowers out of their bad loans (that may be mandated,) market pressures will cause a gradual rise in long-term rates.
Mortgage interest rates are a combination of the risk-free rate, the inflation premium, and the risk premium. Risk premiums during the bubble were artificially low. If they weren't, our banking system would not be in trouble, and the bailout of the GSEs would not have been necessary. When the government took over the GSEs, they knowingly took on the investment risk in order to control the risk premium in the open market. This allows them to keep rates artificially low during the upcoming restructure period (I am of the opinion that the government took control of the GSEs to rid the market of toxic paper through a combination of low interest rate refinancing and foreclosure). Government ownership of the GSEs is not going to be a permanent condition, unless of course the government wants to be the defacto subsidized mortgage insurer of the country forever. At some point, the government will want to get out of the mortgage insurance business, particularly since it will not be profitable. Risk premiums will rise to market when the government moves to get out of the business. Three to five years from now, I would look for the government to spin off the GSEs once again (they did this first in the early 70s). I doubt it will take that long for mortgage interest rates to rise again, so if you ever thought about refinancing, now is the time.
Just in case you needed a reminder of what caused this problem, today's featured property was purchased with an Option ARM with a 1.5% teaser rate. Restructuring this borrower into a mortgage they could afford would require a very low interest rate and likely some significant principal reduction. Since this is well outside of the parameters for a reasonable restructuring, and since this wasn't a GSE insured loan, it is another foreclosure-in-waiting.
Today's featured property demonstrates the living-off-your-house mindset in action. Apparently, all you had to do was buy a house, any house, and start extracting money from it. It didn't require any money of your own to invest, and if things go bad, well... it's not your problem. This house was purchased on 2/10/2006 for $705,000. The owner used a $564,000 first mortgage, a $141,000 second mortgage, and a $0 downpayment. On 9/29/2006, a mere 7 months later, the property was refinanced using a $632,000 first mortgage and a $158,000 second. This netted the owners $85,000 in mortgage equity withdrawal. That is the median income in Irvine, and these people got it simply for owning a house for 7 months! Actually, it is better than that because if you earned $85,000, you would have to pay taxes and have withholdings. To net $85,000, you would need to be making more like $120,000. Further, to get this in 7 months, you would need to be making $205,000 per year. That is one hard working house!
I profile these day after day. Are you starting to get a sense how common this was? Look at how much money these people got to spend for doing absolutely nothing. Is it any wonder houses were such a popular investment? Was it logical to think this could go on forever?
As a society during the real estate bubble, we put enormous sums of money into assets that produce nothing. This isn't like investing in a factory or machinery or infrastructure of some other sort of productive use. These are houses. They only have consumptive value. There is no production here. Is this where society's resources should be diverted?
How can a society thrive when it ties up all its resources in non-productive assets? I joke about hard-working houses because the whole idea is so absurd. Imagine if we took every resource in our economy and put it into house production. For a time, everything would be OK because everyone would be working in construction, they would be making money, and we would all have houses, but what happens once we were done? Houses can't produce anything else. Once the boom was over, the entire economy would collapse because there are no productive assets.
This is basically what we did since the collapse of the NASDAQ stock market bubble. Our manufacturing base never did recover from the recession of 2001. When liquidity was added to the financial system, this money poured into mortgage loans rather than business infrastructure. It is a misappropriation of resources that will likely haunt us for quite some time.
Sometimes I come across a property where the circumstances around the speculative purchase lead to one of two possible conclusions: fraud or cluelessness. I am giving the benefit of the doubt to call this one clueless. This property was purchased in April of 2007. The news of the subprime implosion were on the front page. News of weakness in the housing market was everywhere as sales volumes were already declining and prices were dropping in many markets. And, of course, outlets like the IHB were screaming from the rooftops that prices were going to crash. It was in this environment that our flipper purchased today's featured property.
The purchase allowed the previous owner who purchased in 2004 to sell at a small profit. It is the kind of circumstances that also has potential for fraud, particularly since the property went into foreclosure in just over a year after its purchase.
But was it really clueless? The flipper didn't have any money in the transaction. This was a 100% financing deal, so Affiliated Funding provided the money, and the loan was packaged and sold in the secondary market. Some faceless investor is eating the loss. If prices had rebounded, this flipper would have made money. If it went down (which it did in a big way) then only their credit score was at risk. In those circumstances perhaps those of us who did not participate were the clueless ones...
What really caught my attention with this property was the discount. The asking price is 34% off its 2007 purchase price. That is a substantial drop. Perhaps they are hoping for multiple bids over asking. Perhaps there are enough knife catchers out there that they will succeed. In the comments recently, we were reminded about all the bullish commenters in the early days of the bubble blogs who were certain that if prices dropped 10% that investors would swoop in and buy up the entire inventory. This one is 34% off. Where are they now?
If you haven't stopped by, 
